Thursday, May 10, 2012

Why the Housing Bubble?

Who's really to blame for the housing fiasco, and who caused all the problems?  The bankers?

Well, a new report attributes the bubble and its subsequent bursting to human nature.

In other words, it's nothing more nor less than the age old situation of human greed taking over and then eventually ending in widespread fear taking its place.

In other words, high prices lead to higher prices until they don't. Then at some point fear replaces greed and prices crash.

Both the upside and downside are sometimes referred to as the recency bias (simply the extrapolation of present price gains or losses into the indefinite future) at work.

When home prices increased during the ten years from 1996 to 2006, people got used to a one way "no lose" bet. As more people jumped into the market for homes, prices increased some more, people bet even more, and so on.

Eventually the old adage that "If something can't go on forever, it won't" reared its ugly head. Then the prices crashed and the bubble burst.

Even though that's not the conventional wisdom and probably not what most people want to hear, a new study from the Boston Federal Reserve confirms that's exactly what happened.

The Pogo rules have come into play once again. Boston Fed: Housing crisis wasn't industry's fault says this in part:

"The cause of the housing crisis wasn’t the financial industry deceiving mortgage borrowers and investors but instead overly optimistic beliefs about house prices, according to a research paper released by the Boston Fed.

The paper, written by Boston Fed senior economists Christopher Foote and Paul Willen as well as Atlanta Fed research economist Kristopher Gerardi, cites 12 facts they say refute the popular story that industry insiders were to blame. . . .

“Had there been a Dutch Tulip Inquiry Commission nearly four centuries ago, it would no doubt have found tulip salesmen who fraudulently persuaded people to borrow money they could never pay back to buy tulips,” the authors said.

But they said the U.S. house price bubble really wasn’t any different from the mania for Dutch tulips." 

Summing Up

While we can't control human nature and the tendency to overreact to both fear and greed, we should try to recognize abnormal conditions when things appear to be either too good or too bad to be true.
By so doing, we can either make money or at least avoid losing a whole lot of it.

Reversion to the mean is real. 

Corrections in prices tend to occur when things get out of hand, either on the upside or the downside.

Trend lines are indicative of what's going to happen.

We just don't know exactly when.

That's why we are always well advised to study and learn from the past.

As they say about history, it may not repeat itself, but it does rhyme.

Thanks. Bob.